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About The Evergreening of loans


Recently, Reserve Bank of India Governor, while addressing bank board, raised concerns over banks using innovative methods for evergreening of loans.


GS III: Indian Economy

Dimensions of the Article:

  1. Evergreening methods used by Banks, as highlighted by the RBI Governor
  2. Evergreening of loans
  3. Reasons for financial institutions engaging in the evergreening of loans
  4. Risks associated with evergreening of loans

Evergreening methods used by Banks, as highlighted by the RBI Governor:

  • Loan Exchange: Banks engage in evergreening by facilitating the exchange of loans or debt instruments between two lenders. This practice involves the sale and subsequent buyback of loans, allowing both lenders to artificially maintain the appearance of performing loans.
  • Structured Deals with Stressed Borrowers: Banks persuade financially stable borrowers to enter into structured agreements with borrowers experiencing financial difficulties. This strategy aims to conceal the financial stress faced by the struggling borrower. By involving reliable borrowers in these transactions, it creates a false sense of stability and financial health for the stressed party.
  • Use of Internal Accounts: Banks employ internal or office accounts to manipulate the repayment obligations of borrowers. By making adjustments within these accounts, banks can mask the true financial distress of the borrower. This approach provides temporary relief while disguising the underlying financial problems.
  • Renewal or Disbursement of New Loans: Banks engage in evergreening by renewing existing loans or disbursing new or additional loans to stressed borrowers or related entities just before the repayment date of previous loans. This tactic allows the borrower to meet its repayment obligations temporarily without addressing the root financial issues.

Evergreening of loans

  • Definition: Evergreening of loans is when financial institutions extend or renew existing loans for borrowers facing repayment difficulties.
  • Additional funds and modified terms: It involves providing borrowers with additional funds or rolling over the existing debt with altered terms or conditions.
  • Maintaining a healthy credit profile: The purpose is to create the impression that the borrower is making timely repayments and has a positive credit history.
  • Illusion of financial stability: By continuously obtaining new loans, borrowers can sustain the appearance of ongoing financial stability despite underlying repayment challenges.

Reasons for financial institutions engaging in the evergreening of loans:

Avoiding recognition of non-performing assets (NPA):

  • Financial institutions aim to prevent loans from being classified as NPAs on their balance sheets.
  • This helps them avoid the need to make higher provisions, which can impact their profitability.
  • Loans become NPAs when the interest or installment remains unpaid for more than 90 days.
  • Evergreening allows banks to delay the classification of loans as NPAs.

Maintaining a positive relationship with borrowers:

  • Financial institutions may engage in evergreening to maintain a favorable relationship with borrowers.
  • By extending additional credit or modifying loan terms, they can retain clients who might otherwise default on their loans.
  • This approach helps preserve customer loyalty and avoids potential reputational risks.

Risks associated with evergreening of loans:

  • Misleading financial health: Evergreening artificially inflates the quality of a financial institution’s loan portfolio, which can mislead investors, regulators, and the public about its true financial health.
  • Short-term solution, long-term instability: While evergreening may provide a temporary solution to prevent immediate defaults, it can lead to a cycle of increasing debt and further financial instability for both borrowers and lenders in the long run.
  • Systemic risks: Evergreening of loans can be problematic for the overall stability of the financial system. It masks the true extent of bad loans in an economy, creating systemic risks and distorting the assessment of creditworthiness.
  • Misgovernance and unethical practices: Evergreening often involves an unhealthy relationship between bankers and borrowers. It is a form of misgovernance where bad loans are made to appear good through additional lending to troubled borrowers.
  • Fund diversion and indirect evergreening: In some cases, borrowers engage in fund diversion by borrowing money from weak banks through related parties. Instead of using the funds for productive investments, they increase their debt levels, contributing to misallocation of resources and crowding-out effects.
  • Detection challenges: Evergreening activities are often overlooked and not easily detected, making it difficult to address the risks associated with this practice in a timely manner.

Source: Indian Express

December 2023